CHAPTER 10Covenants and the Loan Agreement

Loan agreements generally include legal requirements, or covenants, that govern borrower behavior through the life of the loan. The loan covenant package theoretically sets the barrier in the Black–Cox Model and helps to create value for the lender in addition to regular payments of interest. The value created likely takes the form of higher recovery rates should default occur, or additional lender income through interest‐rate resets or fees charged by the lender to waive covenant violations. This chapter provides an overview of a typical loan agreement and catalogs the more common loan covenants.

Direct loans are governed by lengthy agreements between the borrower and lender, generally structured as follows:

  1. Definitions. Like most financial agreements, direct loan agreements begin with definitions and measures. Definitions for over 200 terms are generally found, including calculations for such variables as EBITDA, the base rate, interest spread, and fees and definitions of default.
  2. Loan commitment. This section spells out the size of the loan or loans, drawdown and repayment schedules, payment procedures, voluntary and involuntary prepayment. It also specifies the terms of payment, including interest calculations, timing, and what constitutes default. Loan fees and expenses are also covered.
  3. Conditions precedent. Here the lender specifies what final conditions are required before the loan is made. Generally, the items verify the ...

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